TY - JOUR
AU - Pindyck,Robert S.
TI - Irreversible Investment, Capacity Choice, and the Value of the Firm
JF - National Bureau of Economic Research Working Paper Series
VL - No. 1980
PY - 1986
Y2 - July 1986
DO - 10.3386/w1980
UR - http://www.nber.org/papers/w1980
L1 - http://www.nber.org/papers/w1980.pdf
N1 - Author contact info:
Robert S. Pindyck
MIT Sloan School of Management
100 Main Street, E62-522
Cambridge, MA 02142
Tel: 617/253-6641
Fax: 617/258-6855
E-Mail: RPINDYCK@MIT.EDU
AB - A model of capacity choice and utilization is developed
consistent with value maximization when investment is irreversible
and future demand is uncertain. Investment requires the full
value of a marginal unit of capacity to be at least as large as
its full cost. The former includes the value of the firms option
not to utilize the unit, and the latter includes the opportunity
cost of exercising the investment option. We show that for
moderate amounts of uncertainty, the firm's optimal capacity is
much smaller than it would be if investment were reversible, and a
large fraction of the firm's value is due to the possibility of
future growth. We also characterize the behavior of capacity and
capacity utilization, and discuss implications far the measurement
of marginal cost and Tobin's q.
ER -